Unease about lack of German adjustment

International unease is growing at the relative lack of economic adjustment by Germany and other European creditor nations, which is aggravating financial and social strains on the struggling debtor countries in the south. This is seen as an unfavourable accompaniment to the otherwise beneficial, though painful, rebalancing of the European economy.

Particular attention focuses on the German current account surplus. According to latest projections from the Organisation for Economic Cooperation and Development, this will increase to 6.4% of GDP this year from 5.7% in 2011, as imports slow and German companies mount successful export campaigns outside the euro area.

The Dutch current account surplus is forecast at 8.4% this year, but this at least represents a fall from the unusually high 9.7% in 2011.

The German surplus is only slightly below the pre-crisis high of 7.5% of GDP in 2007. Most other large countries with formerly badly skewed current account positions, including China, Japan, and the US, have now sharply lowered their external surpluses or deficits.

The persistently high surpluses among Europe’s creditor nations come at a time when sharp falls in domestic demand have reduced southern countries’ previously unsustainably high current account deficits towards much better balance. The lack of counterbalancing developments in northern Europe is seen as a sign that solvent northerners in economic and monetary union (EMU) are still not doing enough to help the south by boosting domestic demand.

The shortcomings in policy coordination in Europe, despite signs that EMU members are repairing some of the system’s underlying flaws, are leading to frustration among policy-makers.

Concern is mainly building up behind the scenes, rather than being aired in public. This is because there is no real prospect that Germany could somehow take action to weaken the real factor behind its impressive current account performance – the very high competitiveness of German companies on world markets.

The European Central Bank (ECB) has spoken warmly in recent weeks of significant economic rebalancing in Europe in current account positions, competitiveness and public finances.

Peter Praet, the ECB’s chief economist, pointed out on Friday how much correction was necessary after real effective exchange rates in Greece, Ireland, Italy, Portugal and Spain appreciated on average by 16% relative to Germany between 1999 and 2008, whereas the real effective exchange rate of the euro appreciated by only 3% over the same period.

However, there is some uncertainty about how much of the rebalancing has been due simply to collapsed internal demand in the debtor states, and how much reflects more permanent structural reasons that will survive any eventual upturn.

Germany’s Bundesbank, which supplies far more granular information about individual country developments in Europe than the ECB, produced a detailed account of EMU rebalancing in its November Monthly Bulletin. It noted that pre-crisis current account deficits of up to 15% of GDP in 2007-08 in Greece, Ireland, Spain, Italy and Portugal had now been greatly reduced (with the exception of Italy where the deficit remains at a relatively low 1 %) or had been turned into a surplus (in the case of Ireland).

These changes have been partly brought about by sharp declines in domestic demand between early 2008 and spring 2012, of around 26% in Greece, 22% in Ireland, 14% in Portugal, 13% in Spain and 9% in Italy, with the resulting drop in import volumes ranging from 9% in Ireland to 42% in Greece. ‘It is often feared that, in a future cyclical recovery in the peripheral countries, imports and current accounts could again rise strongly,’ the Bundesbank observed drily.

Several countries have made far-reaching efforts to slash unit labour costs and refocus industry on the export sector, with export volumes up by 5% in Italy, 6% in Portugal, 7% in Spain and 10% in Ireland between early 2008 and spring 2012, contrasting with a dramatic 20% fall in Greek exports over that period.

The Bundesbank however admits that the otherwise rosy picture is disturbed by Germany’s own 10% increase in export volumes over the four years. This reflects German industry’s long-term drive to build up export markets outside the euro area, a development sometimes underestimated by foreigners.

For example, in an article in the Financial Times on 7 November, Gerard Errera, a former French ambassador to the UK, asked whether Germany would be ‘increasingly tempted to look towards the wider world – Russia, China and other emerging markets’, claiming that more than half of Germany’s current trade was still within the euro area. In fact, this apparently feared trade diversification has already taken place. According to Bundesbank figures for 2012 so far, in reality, only 38% of German exports and imports are now with euro members.

According to latest statistics, German trade with non-EMU members is growing much more quickly than that within EMU, including for the three non-euro countries (China, the US and the UK) among Germany’s top five world trading partner (exports and imports combined).

On present trends, China will overtake France towards the end of next year as Germany’s single most important trading partner. German firms’ monthly sales to China are more than those to Spain, Portugal, Ireland, Greece, Finland and Hungary combined – roughly the same as exports to Germany’s No.2 trade partner, the Netherlands.

Concern about persistent euro area current account imbalances is part of wider unease at what southern countries call the unfair sharing of burdens in Europe. This has been exacerbated by financial market fragmentation and freezing of southern credit markets that are heavily penalising southern European companies competing with German and other northern rivals.

These worries were broadcast by the OECD last week when it called on ‘countries with robust fiscal positions (including Germany and China) to provide ‘temporary fiscal stimulus’.

Underlining its fears that not enough structural adjustment is taking place in Europe, the OECD says cyclically-adjusted current account deficits in southern Europe, as well as Germany’s cyclically-adjusted current account surplus, are some way above the absolute levels that have been reduced by the economic slowdown – raising the fear that imbalances could balloon again after any recovery.